Rising interest rates

Bank wholesale funding rates for longer terms have moved higher this past week, not because of any startling fresh inflationary news in New Zealand, but because of a change in things overseas. Comments from the Bank of England and Fed. in the United States suggest that in both countries the expected tightening of monetary policies will come sooner than people have been thinking.

In the UK it is possible interest rates will start to be pushed up before the end of the year, and in the United States rate rises in 2022 are now more commonly expected that commencement in 2023.

These changes in tightening timetables come about as central banks are showing signs that they are taking rising inflation more seriously than before. This applies here in New Zealand as well and our central bank is likely to raise its official cash rate by 0.25% in October, November, and February.

If they do, then they won’t actually be the first mainline central bank to do so. The Norwegian central bank this week lifted its cash rate from 0% to 0.25% and expects to take it to 1.25% by the end of next year with the next rate rise expected in December.

The benchmark gauge of interest rate pressures around the world, the ten-year US government bond yield, has jumped this week to just over 1.5% from 1.3% last week. This is the highest level since June.

This week we have seen the one-year swap rate which forms the base from which banks calculate their cost of borrowing money to lend fixed for one year, hold steady at 1.1%. The NZ three-year swap rate has crept up to 1.64% from 1.62%. These rates largely reflect expectations for NZ monetary policy – which have not moved this week. A rise in the official cash rate of 0.25% is anticipated for next Wednesday.

The five-year swap rate has however climbed to an 18-month high of 1.87% from 1.78% last week – not that many people are now borrowing fixed five years given the 1%-plus lift in that fixed mortgage rate for almost all lenders in recent months.

My expectation for the one-year rate in September each year is shown in the first column of the table here. I focus on that rate because there are many people who have fixed one-year repeatedly since 2009 and the strategy has worked very well.

The second column shows what the one-year rate will average over the next 2-, 3-, 4-, and 5-year periods. The last column shows the current minimum 2 – 5-year fixed rates charged by the six biggest lenders I track. Note, usually the Australian-owned banks have rates above the minimums shown here offered usually (but not always) by KiwiBank and TSB. 

If these forecasts prove correct (I’d give that a 10% probability), rolling one-year fixed will deliver an average rate for the next two years of 3.27%, three years 3.68%, four years 3.86%, and five years 3.89%.

The last column shows what the current minimum fixed rates are for those time periods. Given that there is a rate premium one should be prepared for rate certainty, rolling one-year fixed will easily deliver a cost higher than one could get by fixing at the moment – if the forecasts are right.

If I were a borrower, what would I do?

Global inflation worries are rising. Wholesale borrowing costs banks must pay are increasing. Banks will be looking to take advantage of the fog of confusion to rebuild shattered margins. Therefore, mortgage fixed rates have already gone up and when the OCR actually increases banks will tweak things upward again.

Personally, if I had taken the 2.19% one-year candy, and that rate is now rolling off I’d probably mainly fix three years currently.

Note that nothing I write here is intended to be personal advice. You should discuss your financing options with a professional.